Variance Analysis
Variance analysis is the link between what is in your budget and what actually did happen, which you can see once the monthly accounts have been finalised.
A budget or forecast is a planning tool which will include some speculation and guesswork as well as some time-tested knowledge of seasonal patterns and behaviours. It’s important to understand why differences occur so we can see what impact that can have on the company’s finances as a result.
Example:
Budgeted Cost of SalesActual Cost of SalesVarianceCommentsBudgeted SalariesActual SalariesVarianceComments
| Budgeted Sales | Actual Sales | Variance | Comments |
|---|---|---|---|
| £10,000 | £8,000 | £-2000 | Sales were 20% lower due to stock shortages |
| £5,000 | £4,500 | £500 | On the face of it, it looks like we are £500 better off! However, original sales budgeted a gross margin of 50% (£5000/£10000) when the actual margin achieved was 44% (£3,500/£8,000) |
| £2,500 | £2,300 | £200 | Forecast wage increase was lower than expected. |
Are these results a one-off occurrence or are our suppliers proving unreliable in the longer term and can we sustain levels at the forecast margins?
Remember, the cause and significance of the variance can be more important that whether the variance is positive or negative and that information needs to be used as a future planning tool. Lower sales or profits will have an effect on future cash-flow. It is easy to be distracted by sales volume and turnover which will give a positive boost to the working capital in the short term, but lower profits will have a longer term impact.
Example:
| Budgeted Turnover | (2,500 units at £450) | £1,125,000 |
| Actual Turnover | (2,650 units @ £425) | £1,126,250 |
| Sales Variance: | £1,250 increase in turnover |
This looks good as we have sold more units and generated more turnover than expected. However, in order to understand the impact this has, we need to look at the effect of the reduction in price on the forecasted profit:-
| Budgeted Profit at 50% | (2500*225) | £562,000 |
| Actual Profit @ 47% | (2,650 *£200) | £530,000 |
| Profit Variance, decrease in profit | £32,000 |
